The CEO’s Toolkit: Capital Allocation in a PE-Backed World
Most CEOs Neglect This Critical Skill
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👋 Hi, it’s CJ Gustafson and welcome to Looking for Leverage. Each edition dives into the real-world playbooks PE-backed execs use to drive results.
Today we’re talking about capital allocation, and how it’s one of the most powerful, yet least discussed, skills a CEO needs to learn. Let’s get to it.
“It is almost impossible to overpay the truly extraordinary CEO.”
– Warren Buffett
Every CEO has three core jobs:
Run a good company (Operations)
Tell a good story (Investor Relations)
Deploy capital effectively (Capital Allocation)
Most CEOs focus 80% of their time on the first two. Yet it's the third, capital allocation, that often has the highest leverage and the least guidance.
From Manager to Capital Allocator
The business world traditionally separates operators from investors. It’s looked at as a binary “either / or” equation, where you’re either the one providing capital, or receiving it. But in a private equity-backed context, the CEO straddles both roles. In fact, I’d argue it’s an even more concentrated investment under stricter timelines.
While an institutional investor might diversify across dozens of assets, a CEO has one asset: their business.
What’s more, PE-backed CEOs are held to a shorter timeline, typically 3–5 years, compared to institutional investors who can ride out cycles.
If it’s not apparent yet, capital allocation is a required skill set at the top.
Yet, few, if any, CEOs are given the requisite experience to be great capital allocators before they get there. They climb the ranks by being great at a subject area - like sales or product. But when they get to the CEO role, they are expected to shape the future of the company by strategically placing chips on the table. They enter the realm of investor.
Buffett again:
“The heads of most companies are not skilled in capital allocation. Their inadequacy is not surprising. Most bosses rise to the top because they have excelled in an area such as marketing, production, engineering, administration…
…It’s as if the final step for a highly talented musician was not to perform at Carnegie Hall, but instead, to be named Chairman of the Federal Reserve.”
Your Toolkit
Capital allocation is not just about spending more or less money. It’s about return on invested capital (ROIC), and how intelligently you compound shareholder value.
William Thorndike’s The Outsiders defines capital allocation as:
“The process of deciding how to deploy the firm’s resources to earn the best possible return for shareholders.”
You have five basic deployment levers:
Invest in the core business
Acquire other businesses
Issue dividends
Pay down debt
Repurchase shares
And three ways to raise capital:
Internal cash flow
Debt
Equity
This is your capital allocator’s toolkit.
“Stated simply, two companies with identical operating results and different approaches to allocating capital will derive two very different long-term outcomes for shareholders.”
-The Outsiders, by Willian Thorndike
Let’s walk through each of the relevant levers from the private equity operator's perspective:
PE Capital Allocation in Practice
From the perspective of a PE-backed operator, investing in the core business and acquiring other companies are the most practical, most common capital allocation tools. These are the moves that drive top-line growth, expand margins, and justify valuation uplifts during a 3–5 year hold period.
Yes, servicing debt is always top of mind—but paying down principal is typically deferred until you’re closer to an exit. Why? Because keeping leverage in place allows you to amplify equity returns without diluting the cap table. As long as covenants are under control, the financial model favors debt-fueled growth.
Dividends have long been considered an inefficient way to return capital—taxed once at the company level and again at the individual level. But in the PE world, dividends have a specific purpose: they give sponsors a way to extract cash earlier, especially during periods when exit conditions aren’t favorable. They’re used strategically to realize value without selling the asset.
Share repurchases, meanwhile, are largely irrelevant for private companies. These only become relevant when nearing a public exit—and even then, only as a method of capital structure optimization or return enhancement. For PE operators, it’s a non-factor.
So let’s use a case study to explore the first two.
The Capital Cities Playbook: A Case Study in Capital Allocation
The clearest blueprint of how to allocate capital with operational discipline comes from a surprising place: broadcast media.
Capital Cities, a scrappy media company that ultimately acquired ABC and later sold to Disney for $19 billion in 1995, was a masterclass in both operational excellence and capital deployment. Under the leadership of CEO Tom Murphy and COO Dan Burke, Capital Cities ran what we would now call a disciplined, high-ROI roll-up strategy.
Murphy owned capital allocation, acquisitions, and strategy.
Burke ran the day-to-day business and drove operational excellence.
Their mantra: “Burke creates the cash, and Murphy allocates it.”
This clear division of labor—between operations and capital—allowed Capital Cities to scale aggressively while staying lean and focused.
Invest in the Core Business
People First, Always
Capital Cities believed capital allocation began with human capital. They hired smart, high-upside operators—even those without direct industry experience—and gave them wide autonomy to run local markets. The corporate HQ was intentionally lean. Decision-making was pushed to the field.
“Hire the best people—and then leave them alone.”
This extreme decentralization wasn’t just about culture—it was a capital allocation strategy. Murphy and Burke believed that local market leadership created margin dominance, especially in local news, which in turn drove outsized ad revenue.
“The company was careful, not cheap.”
– On Capital Cities’ approach to investing in local news talent and technology
They were ruthless about unit economics:
Didn’t chase scale for its own sake
Shut down or sold underperforming divisions
Prioritized long-term value creation over short-term optics
As Murphy said:
“The goal is not to have the longest train, but to arrive at the station first using the least fuel.”
Some of the young stars who came out of this coaching tree include Bob Iger, future CEO of Disney, and leaders at Hearst, Pulitzer, and NBC Universal.
Acquire Other Businesses
Discipline Creates Conviction
Murphy’s strength as a capital allocator was grounded in operating leverage. He didn’t make acquisitions hoping they’d become more profitable; he had confidence they would be, because Burke’s team had a repeatable integration model.
This gave him what every PE operator wants: conviction.
“I get paid not to make deals, but to make good deals.”
– Tom Murphy
Knowing that they had a bullpen of young, hungry, talented execs ready to step up, with the operational rigor to execute, the acquired units would be made more profitable, lowering the effective price paid.
Capital Cities:
Only pursued acquisitions that met strict return hurdles (double-digit after-tax returns over 10 years without leverage)
Used leverage intelligently, and paid it down typically within three years so they could re-up and buy something else
Integrated fast and efficiently, boosting margin and cash flow post-close
They weren’t playing financial engineering games. They were running an operating system that worked, and they scaled it through smart capital deployment.
“We just kept opportunistically buying assets, intelligently leveraging the company, improving operations, and then we’d take a bite of something else.”
Building a “Perpetual Motion Machine for Returns”
Murphy and Burke’s unique blend of operating and capital allocation skills created what one investor called “A perpetual motion machine for returns.”
It was a combination of effectively allocating capital to hire the best people, and sometimes paying up for top media talent, paired with their selective acquisitions that resulted in a remarkable 19.9% internal rate of return over 29 years. This outpaced the 10.1% return of the S&P 500 and 13.2% return for an index of leading media companies over the same time period.
While we broke out the five unique types of capital allocation, the best approach is to stack more than one together. It goes without saying, but you won’t have much capital to allocate if you don’t have efficient operations. And you can make much larger, and more informed bets, when you know acquiring a company is derisked, and actually an arbitrage opportunity.
Given that capital allocation isn’t taught in business school, CEOs should make the effort to look at how other greats at other playbooks from history to see how the greats have applied lesson.
In Case You Missed It…
Last week we talked about org complexity, and how it’s a lot harder to forecast than revenue. Especially when you add M&A to the mix…
It’s tempting to think that scaling a company means making your business model more complex. You add SKUs, expand channels, localize pricing, maybe dip your toe in the enterprise pool.
But here’s the thing: the model is usually the easy part.
The real complexity creeps in through the people. Every new person adds a node to your system, and with them come more meetings, more approvals, more misunderstandings. Your forecast may look linear, but your org chart is growing geometrically.
This is another reason why board service is important for CEOs and CXOs. As a board member you learn to think about capital allocation with a group of people vs. having to learn the ropes by yourself. At least that was my experience - YMMV.